By Sonam Reel

Climate change and its impact on the global economy have been discussed at various international forums. During the Davos conference, Former US Vice-President Al Gore has referred to the crisis as “way worse than many realize and intensifying way faster than people appreciate”. To tackle the looming crisis, green bonds emerged as a financial sector solution to promote green investments and environmental sustainability. Over 12 years after the launch of the first green bond, the portfolio has grown rapidly and there is a lot of excitement for their potential to spur “green growth”. However, a closer look into the market shows that there is little transparency and unclear principles regulating these securities.

What are “green bonds”?

Green bonds are structured as any other debt instrument offered by governments and private institutions, but with an explicit focus on environmental sustainability. Depending on their structure, bonds can be tax-free, making them very attractive to investors. These instruments can be either short or long-term, but the tenors are usually longer due to their underlying purpose.

The International Capital Market Association (ICMA) identifies four principles in the structuring of green bonds:

1. Use of proceeds: this identifies the underlying investment for which the issuer is raising funds. For example, a bond issued for purposes of renewable energy.
2. Process for project evaluation and selection: the issuer needs to provide detailed information on the environmental sustainability objectives and transparency on the selection of the project.
3. Management of proceeds: to ensure efficient and transparent management of investor funds, the issuer is required to inform investors on movement of funds between accounts and if funds will have oversight by an auditor.
4. Reporting: annual reports to be available to investors demonstrating the allocation of funds and ongoing impact.

These principles however are not enforced or mandatory.

Growth of green bonds: some numbers

As of 2019, the size of the green bonds market is rising, with the projected portfolio for the end of 2019 over $250 Bn. Green bonds had a growth rate of 67% in 2019 compared to the same time in 2018.

The first green bond was launched in 2007 by the European Investment Bank followed by the World Bank in 2008. Over 12 years later, momentum is picking up, not only in western economies but also in emerging markets and developing economies. Kenya for example listed its first green bond in January 2020 on the London Securities Exchange (LSE), opening up investment channels for foreign investors and giving domestic companies opportunities to expand across the globe.In 2020, the UK government launched its most ambitious green bonds initiative to date in East Africa.

Green bonds are also increasingly being discussed in key international forums. For example, at the meeting for the European Central Bank in Frankfurt, the role of green investments was emphasized by the President of the European Central Bank, Christine Lagarde, who also included climate change as one of her top priorities upon taking office in 2019. In his 2020 visit to Washington DC, Kenyan President Uhuru Kenyatta highlighted that “climate change is real”, bringing the example of the locust invasion in East Africa, which is linked to climate change. The issue is also at the centre of US politics, being discussed extensively in democratic debates and will most likely be at the centre of the 2020 US presidential elections.

Green and sustainability bonds are also part of the United Nations Sustainable Development Goals (SDG). Based on the 17 goals, green bonds or sustainability bonds are in line with Goal 13, Climate Action, however there is an overlap with other goals. The World Bank and the European Investment Bank have led the green bonds initiative and other institutions are coming up with “greener” ways of investing in portfolios. 

How green are green bonds?

The growth in numbers are evident but what about the principles regulating these securities?

Despite being in the market for over 12 years, green bonds are not standardized or governed by a binding set of principles. A contributing factor to the delay in regulations is that the current portfolio size of green bonds is small in comparison to other debt securities. Green bonds in 2018 accounted for less than 1% of total bonds.

This has resulted in the spread of “greenwashing”, which happens when companies label bonds as “green” as a marketing strategy with no or minimal impact on the environment. For example,  China faced criticism for labelling one of its bonds as “green” despite the funds being used to finance coal-burning power plants. China’s defence was that the funds were being used for the development of new coal plants that used modern and cleaner technologies. Similarly, in 2019 Italian electricity giant Enel was accused of greenwashing when it launched a bond that had no direct green investment but included a commitment to increase its pay-out if the company failed to meet its environmental targets by 2021.

To fill this gap in regulation, the “Climate Bonds Initiative” (CBI) was established in 2010 to increase transparency in the sector. CBI is a non-governmental organization that provides a certification called “Climate Bonds Standard and Certification Scheme” following a stringent screening of the issuers and their investment strategy. This certification, however, is currently not mandatory. In addition to CBI, there are various regulatory bodies that are working on developing the principles and guidelines for green bonds including the European Union.

The expected growth for green bonds for the year ending 2020 is $350Bn and as this focus grows globally, adequate regulation and certification will be critical for the success of the market. Increased transparency will boost investor confidence and it will positively impact the environment.